Shell companies The Fine Line Between Good and Bad

The Panama Papers leak has prompted policymakers in many countries to call for a crackdown on shell companies. But not all such firms are illegal, and some make good business sense.
Panama is a common destination for those wanting to set up shell companies.

German Economics Minister Sigmar Gabriel has come up with the most drastic demand so far in response to the leak of the so-called “Panama Papers": He wants all shell companies worldwide to be outlawed.

On Sunday, the International Consortium of Investigative Journalists revealed the gigantic scale on which a law firm in Panama provided dictators, arms dealers, drug traffickers but also politicians, entrepreneurs and wealthy investors with obscure corporate constructs whose only aim may be to save money.

Investigations have been launched around the world — against sports stars such as soccer player Lionel Messi, but also against soccer’s world governing body Fifa. The prime minister of Iceland, Sigmundur Gunnlaugsson, resigned Tuesday evening following mass demonstrations against him because the papers show he and his wife owned an offshore firm.

Banking supervisors around the world are swarming out to scrutinize the role of banks. Germany’s Federal Financial Supervisory Authority, Bafin, has requested information from several Frankfurt-based banks about their offshore deals.

I think it would be counterproductive to ban all offshore firms. Good economic reasons exist for using such companies, for example, to avoid double taxation. Clemens Fuest, Head of Ifo Economic Research Institute

Shell companies have become synonymous with tax evasion and money laundering. But does every offshore firm really serve illegal purposes? No, say many economists and lawyers.

The new head of the Munich-based Ifo economic research institute, Clemens Fuest, warned against taking exaggerated action in response to the Panama Papers. “I think it would be counterproductive to ban all offshore firms,” he told Handelsblatt. “Good economic reasons exist for using such companies, for example, to avoid double taxation.”

State development banks also use offshore firms as part of their investment projects, according to Mr. Fuest. “They don’t want to evade tax,” he said.

Swiss bankers said trusts or offshore companies were in demand among wealthy private clients from countries without well-established legal systems. Local bank staff in such countries sometimes sold information to criminals about how much money rich clients had in their accounts, the bankers said. The anonymity of a trust can offer protection.

Even investors from legally stable countries like European nations can have perfectly legal motives for setting up shell companies: “For example, when they want to gain initial low-cost access to an emerging country or to bundle international joint venture activities in a holding company,” said Björn Demuth of law firm CMS Hasche Sigle.

That explains why Finance Minister Wolfgang Schäuble isn’t going along with Mr. Gabriel’s call for a blanket ban. “We want investment in weaker countries to be possible,” he said. “But we also keep seeing that such constellations are used for other purposes.”

That’s why Mr. Schäuble wants more transparency. The automatic exchange of information is to start next year, making it much easier for tax authorities to follow money flows — and to recognize the ones that are truly illegal.

An example three years ago demonstrated how offshore firms can look illegal at first sight but are in fact legitimate. At the time, a data leak at Singapore-based offshore finance firm Portcullis Trustnet led to the discovery by the ICIJ investigative journalists’ network of five trusts that belonged to Gunter Sachs, a wealthy German industrialist and playboy who died in 2011.

Swiss tax authorities responded by going over his tax statements again and found that everything was above board. The assets held in the trusts had all been properly declared. Mr. Sachs had used them to organize his assets, which were distributed around the world.

Christopher Steckel, partner in the Leisner Steckel law firm, cited examples of offshore structures that made business sense and were legal. Take a German, for example, who owns real estate in the United States. “If a U.S. citizen slips on a banana skin in front of that property, he could sue the German owner for millions in compensation," he said. "If you insert a company in, say, Delaware, the claims will be directed against the company.”

In addition, firms can use an offshore company to hide the fact that they’re investing in a promising startup to prevent competitors from getting wind of their intentions. There’s nothing legally wrong with that.

Nevertheless, even though the use of a shell company doesn’t always mean the owner wants to launder money or defraud the taxman, lawyers admited there are plenty of reasons to mistrust them.

“There’s a big danger of abuse with these structures,” Mr. Steckel said.

We must create transparency; the systematic cover-up must end. Shell companies that still have an anonymous beneficial owner must no longer be allowed. Heiko Maas, Justice Minister

Other lawyers who asked to remain anonymous told Handelsblatt that the lines between legal, illegitimate and illegal were blurred when it came to shell companies. Overall, the anonymity afforded by shell companies was used for illegal purposes much more often than for legal ones, they said. One lawyer, in fact, claimed that almost 90 percent of these constructions were illegal.

The location of offshore companies is also relevant. Panama is one of the four countries that are showing no inclination to take part in the global fight against tax evasion launched by Group of 20 leading economies with the help of the Organisation for Economic Co-operation and Development in the wake of the financial crisis.

“We keep on seeing that tax evasion is an indicator: for corruption, for money laundering, for organized crime,” said OECD tax expert Achim Pross. His boss, OECD President Angel Gurría, has made it clear he wants to ramp up the pressure.

The massive data leak has triggered a political row in Germany over what action to take against illegal shell companies under the E.U. Money Laundering Directive Germany must implement by mid-2017. The finance ministry plans to work up a draft paper by July, and Justice Minister Heiko Maas, a Social Democrat, announced plans for what he called a “transparency register.”

“We must create transparency, the systematic cover-up must end," he said. "Shell companies that still have an anonymous beneficial owner must no longer be allowed.”

Mr. Schäuble agrees with that stance in principle. But he’s not prepared to go as far as the Social Democrats in enforcing transparency.

The E.U. directive calls for a register of “beneficial owners” of all firms, and wants people and organisations that can demonstrate a “legitimate interest” to have access to that register. That group should be large and include journalists and citizens’ groups.

Such a register, however, would fall under privacy rules and Mr. Schäuble wants to avoid integrating it into a website, as the United Kingdom is planning.

Officials in Mr. Schäuble’s ministry pointed out that German corporate law already provides reliable registers — unlike the British system where the information provided often isn’t checked.


Holger Alich is Handelsblatt's correspondent in Switzerland. Dietmar Neuerer reports on domestic politics from Berlin. Donata Riedel covers economic policy from the capital. To contact the authors: [email protected], [email protected] and [email protected]